All star guest poster Carl Smith discusses last week’s El case and his views on pleading rules in penalties. Les
Last week’s opinion out of the Tax Court in El v. Commissioner, 144 T.C. No. 9 (Mar. 12, 2015), announces another major exception to the Tax Court’s pleading rules with respect to penalties. A year ago, I wrote a post about how many Tax Court judges seem to be ignoring or rationalizing away even the nominal Tax Court pleading rules when it comes to penalties — and ruling in a more taxpayer-favorable way when pro se litigants are involved. With this newly-added exception provided by El, the cumulative exceptions have now, as a practical matter, swallowed the nominal rules in most cases. This just underscores the position I took last year that it’s time for the Tax Court to reexamine whether the original penalty general pleading rule should be abandoned, since so many judges are either finding ways around it or ignoring it.
In 1998, Congress adopted section 7491(c), which states that, ‘[n]otwithstanding any other provision of this title, the Secretary shall have the burden of production in any court proceeding with respect to the liability of any individual for any penalty, addition to tax, or additional amount imposed by this title”.
But what happens under that subsection when, as usual, a Tax Court pro se petitioner doesn’t plead anything about penalties in her petition, even though the attached notice of deficiency seeks penalties? Rule 34(b)(4) provides that “[a]ny issue not raised in the assignment of error shall be deemed to be conceded.” In Swain v. Commissioner, 118 T.C. 358, 364-365 (2002), where these were the facts, the IRS succeeded in convincing the Tax Court that section 7491(c) did not change the Tax Court pleading rules when it comes to penalties, so the pro se tax protestor there was deemed to have conceded the penalties by not mentioning them in his petition. In El, these were also the facts, except the IRS worried before trial that it might have the burden of production on penalties, so it included a discussion of why penalties applied in its pre-trial memo. After submitting the case fully stipulated, though, the IRS cited Swain in its regular brief and argued that the taxpayer had conceded all penalties by not mentioning them in his petition. In El, the Tax Court held that Swain was not applicable because the IRS had tried the penalties by consent by discussing them in both its answer and its pre-trial memo. Applying the burden of production on penalties to the IRS, the Tax Court then rejected imposition of one of the penalties — the late-payment penalty — since the IRS had not shown that it had prepared for this non-filer a substitute for return (SFR) under section 6020(b) which could constitute a “return” for purposes of applying a late-payment penalty under section 6651(a)(2) and (g)(2)on unpaid taxes shown on a “return”. The ruling that a failure to prepare an SFR was part of the IRS’ normal burden of production under section 7491(c) was not new; the Tax Court had so held in Cabirac v. Commissioner, 120 T.C. 163, 170 (2003). What was new was the ruling that the IRS had to shoulder the burden of section 7491(c) because it had tried the penalties by consent, even though they were not nominally contested by the taxpayer in his petition.
El provides just another exception to the Swain rule. Another major exception to the Swain rule was found by Jude Marvel (who also authored El) in Wheeler v. Commissioner, 127 T.C. 200 (2006), affd. 521 F.3d 1289 (10th Cir. 2008), where another tax protestor raised largely frivolous arguments in his petition, but his petition also stated: “‘The Petitioner is not liable for any determination of penalties and/or interest in the notice of deficiency” and that ‘The Petitioner is not liable for a penalty at 26 U.S.C. section 6654.’” Wheeler, 127 T.C. at 203. Judge Marvel wrote:
In the petition, petitioner contested his liability for the additions to tax. Although the petition is unclear in many respects and does not follow the format that Rule 34(b) requires for a properly prepared petition, petitioner nevertheless asserted in the petition that he was not liable for the additions to tax, and respondent was put on notice that petitioner’s liability for the additions to tax was an issue. We conclude, therefore, that petitioner assigned error to the additions to tax, see Swain v. Comm’r, supra, at 364-365, and respondent had the burden of production under section 7491(c) to come forward with evidence that it is appropriate to hold petitioner liable for the additions to tax. Therefore, we must review the record with respect to each addition to tax to ascertain whether respondent met his burden of production. Id. at 207.
Judge Marvel went on to find in Wheeler that neither the section 6651(a)(2) nor 6654 penalties could be imposed. The former could not be imposed because the IRS had failed to prove that it had prepared an SFR for the year that could underlie the late-payment penalty — the same defect as in El.
So, under Wheeler, any general contest of the penalties in the petition imposes on the IRS the burden of production with respect to every conceivable sub-issue that forms part of the burden, even though the petitioner does not raise the sub-issue. In effect, the judge polices the IRS on penalties without help from the petitioner to identify specific defects.
If Wheeler and El have not blown enough holes in the Swain general rule, judges have, from Day One after section 7491(c)’s enactment, sua sponte, and seemingly at whim, corrected errors they have seen in penalties that were not mentioned by the parties. For example, in the very first case in which the Tax Court applied section 7491(c), Higbee v. Commissioner, 116 T.C. 438 (2001), one of the things the judge did was insist the parties fix an error the judge alone had noticed in the amount of withholding used by the IRS in the notice of deficiency in computing a late-filing penalty. Id. at 448 n. 8.
In my prior post last year, I also noted that I had researched petitions that were affected by the opinion in Rand v. Commissioner, 141 T.C. 376 (2013), holding that the “underpayment” on which the section 6662 penalty applied did not include disallowed refundable tax credits (except to the extent the credits were used to bring tax down to zero, but not below zero). After Rand was issued, many judges on their own insisted that penalties be recomputed to reflect Rand‘s holding — even though I found that all but one of the petitions in such cases did not even contain a general contest to penalties (and thus, under Swain, the originally-proposed penalties should have been deemed conceded).
One judge who ordered a Rand re-computation ignored and did not address the IRS’ complaint that Swain barred the court from requiring a re-computation, since the taxpayer had conceded the penalties by not mentioning them in the petition.
Another judge, Judge Gale, at least addressed this IRS argument in unpublished orders in three dockets. I will quote him here from his April 15, 2014 order and decision in Faecher v. Commissioner, Docket No. 16049-12, where he entered a decision that was inconsistent with a proposed stipulated decision that both parties had signed where the proposed stipulation did not reflect the Rand holding:
The Commissioner generally bears the burden of production with respect to the liability of any individual for any penalty or addition to tax. Sec. 7491(c). However, we have held that where the taxpayer fails to state a claim with respect to a penalty or addition to tax, the Commissioner incurs no obligation to produce evidence in support of the individual’s liability pursuant to section 7491(c), see Funk v. Commissioner, 123 T.C. 213, 216-218 (2004); Swain v. Commissioner, 118 T.C. 358, 364-365 (2002), at least where nothing in the record suggests the addition or penalty has been incorrectly computed. Where, as here, the record demonstrates that the penalty sought by respondent is erroneously calculated, we conclude that it should not be sustained, without regard to whether petitioner hasstated a claim in the petition concerning the penalty.
In accordance with Rand v. Commissioner, supra, and for the reasons stated therein, we hold that petitioner has no underpayment of tax for 2006, 2007, and 2008 within the meaning of sections 6662(a) and 6664(a), and is therefore not liable for any penalty under section 6662(a) for those years.
So Judge Gale believes that there is an exception to Swain where the information in the record suggests that the penalty has been incorrectly computed (i.e., the court can fix a penalty, even though the taxpayer hasn’t mentioned the penalty).
Having judges state one official penalty pleading presumptive rule, Swain‘s, and then finding huge exceptions to the rule (either ones judges try to justify or ones they don’t even bother to justify) is not a good way to administer the imposition of penalties. It allows for judges to treat taxpayers differently based on improper criteria. I note that the pro se taxpayers who judges helped fix the penalties computed inconsistently with Rand were not tax protestors. By contrast, the taxpayers in Swain and a similar case, Funk, were tax protestors, who were deemed to have conceded the penalties. This is an Equal Protection issue.
I think the Tax Court went off the rails initially in Swain and that Swain should be overruled — leaving the burden of production on penalties on the IRS when the penalties are shown in a notice of deficiency, whether or not the taxpayers specifically mention penalties in their petitions or briefs. Swain was a pro se case, and so only the IRS presented argument on the issue of how section 7491(c) interacts with Rule 34(b)(4). Swain did not discuss the argument that I would have made that the introductory language to section 7491(c) — providing that the subsection applies “[n]otwithstanding any other provision of this title” – causes its rule that imposes the burden of production on the IRS on penalties to override Tax Court Rule 34(b)(4), since Tax Court procedural rules are only authorized by section 7453 (which is a “provision of this title”).
Congress no doubt understood in 1998 that most petitions in the Tax Court are filed pro se and that few will mention penalties, even though those pro se petitioners, if asked, would no doubt, in nearly every case, think that by filing in the Tax Court they contested the penalties, even if they did not specifically mention the penalties in the petition. If section 7491(c) is interpreted not to impose a burden on the IRS in such cases, as in Swain, then one is concluding that Congress enacted section 7491(c) only to help taxpayers who are represented by counsel who would know enough to specifically discuss penalties in the petition. I hardly think that is a reasonable construction of this penalty burden section when Congress specifically made the rule applicable to “individuals”, not all taxpayers.
If Swain is not overruled, and the current situation continues, we are going to be left in a place where judges selectively impose section 7491(c) burdens on the IRS in some, but not all, pro se cases. In cases where petitioners file with counsel, counsel will likely use Tax Court Form 1, which, based on Rule 34(b)(3), asks that taxpayers identify how much of the proposed deficiency is “in controversy” if not all is. Counsel is likely to mention penalties in Form 1. The Tax Court, however, encourages pro se filers to use the much briefer Form 2, which has never complied with Rule 34(b)(3) in that it never asks the taxpayer to indicate how much of the proposed deficiency is in controversy. Now, if Form 2 were modified so that pro se filers were simply asked how much of the deficiency is in controversy or, alternatively, asked if they contested any penalties asserted in the notice of deficiency, the problem posed by Swain would go away, since any indication that penalties are in controversy or that the entire deficiency is in controversy would probably trigger the Wheeler exception to Swain that puts the burden of production on the IRS on all penalty sub-issues, whether those sub-issues are specifically pleaded or not.
As we are now, the IRS is somewhat baffled what to do when a pro se taxpayer doesn’t mention penalties in her petition. So, the IRS may be tempted to protect itself by saying in its pre-trial memo that it will meet the burden of production on penalties. Then, under El, the IRS will have been held to have tried the penalties by consent. In protecting itself when it was not sure it had the burden, the IRS will now be held to have firmly put the burden on itself. This is crazy.
Two final points:
By way of full disclosure, the argument that I make here that Swain is wrong is one that I am currently making to the Ninth Circuit in an appeal of a case named Morales v. Commissioner, T.C. Memo. 2013-192, where a Tax Court judge refused, on a motion for reconsideration, to fix the Rand problem in the case — citing Swain — since the taxpayers did not specifically mention any issue about the “underpayment” before the judge’s original opinion came out upholding the proposed penalties. The briefs in Morales were submitted last summer, and we are awaiting either the scheduling of an oral argument or an opinion (without having been granted oral argument).
Second, the reason El was a precedential T.C. opinion had nothing to do with the pleading issue that this blog post is about. The main issue in the case was whether section 72(t)‘s 10% additional tax on early withdrawals from qualified plans was a “penalty” within the meaning of section 7491(c). If it were a penalty, then the court would have to decide whether the taxpayer or the IRS had the burden of production on whether the taxpayer could escape the penalty by qualifying for one of its many exceptions. The court held that section 72(t) is called an additional tax and is not a penalty, so section 7491(c) does not apply. Therefore, the burden of production and proof on section 72(t) was on the taxpayer under ordinary burden of proof rules that apply to taxes. Thus, the taxpayer was obligated to prove any exception to section 72(t). Since the taxpayer submitted the case fully stipulated — without any information about the possible exceptions — the court held that the taxpayer was liable for the section 72(t) additional tax.